Hungary: Markets Have Stabilized, but Long Road Ahead

IMF Managing Director to visit Budapest to discuss progress with program

Hungary's financial markets have stabilized since last November, when the IMF approved a $15.7 billion loan to back a program designed to ease financial market stress and support economic activity.

But the road ahead is long, says James Morsink, the IMF's mission chief for Hungary.

In an interview, Morsink provides a progress report on Hungary's economy ahead of IMF Managing Director Dominique Strauss-Kahn's visit to the country on January 13. In Budapest, Strauss-Kahn will discuss with senior officials the global economic environment and Hungary's progress on the IMF-supported economic program.

IMF Survey online: What is the main source of Hungary's current economic troubles?

Morsink: The troubles were caused by the confluence of a highly indebted economy and the global financial crisis. Hungary was hit early and hard. The main source of Hungary's vulnerability is excessive borrowing by both the public and private sectors. Government debt amounts to about 67 percent of GDP, reflecting the large fiscal deficits of the first half of this decade. Private sector debt has also grown rapidly, with gross external debt at close to 100 percent of GDP. And bank lending to households and companies is largely denominated in foreign currency, making the private sector vulnerable to a depreciation of the exchange rate.

IMF Survey online: What steps are needed to put the economy back on track?

Morsink: The two main pressure points in the economy are government finances and the banking sector. Since the government has a very high level of debt, it needs to provide reassurance to the people who hold the debt—or are potentially going to finance the debt—that it will be able to meet its future obligations. To provide that reassurance, visible fiscal adjustment is needed. That's the main objective of fiscal policy under the IMF-backed program. The program also aims to ensure that the banking system is prepared to face the risks associated with Hungary's economic downturn, which will weaken loan quality, and with the ongoing global financial crisis, which has tightened bank liquidity. To address these issues, Hungary's parliament has just enacted a bank support law that creates both a capital enhancement facility and a bank borrowing guarantee facility.

IMF Survey online: Should Hungary be considering fiscal stimulus at this point to counteract the economic slowdown?

Morsink: No. The most important thing that fiscal policy can do to support economic activity is to ensure that government debt is sustainable. The only way that investors will be willing to hold government debt is if they believe the government can meet its obligations in the future.

Morsink: since government has very high level of debt, it needs to provide reassurance that it will be able to meet its future obligations (IMF photo)

To preserve investor confidence, the government needs to strengthen its finances. Fiscal stimulus would do just the opposite—it would weaken government finances and make investors lose confidence, which would lead to a much sharper economic downturn than we currently anticipate.

IMF Survey online: How will the program achieve a reduction in Hungary's public debt—and still protect the poor and those on fixed incomes?

Morsink: A key objective of the program is to ensure that poor people are protected from reductions in government spending. For example, the program introduced a cap on the 13th month pension (rather than eliminating it entirely) to make sure that low-income pensioners are not affected. Looking forward, a key challenge is to improve the targeting of social benefits to the people who need them most.

IMF Survey online: How is the IMF-supported program advancing and how do you see Hungary's economic outlook for 2009?

Morsink: The program is on track. So far, financial markets have stabilized, which is a sign that the program is working. The exchange rate has been broadly stable, government bond yields have fallen, foreign parent banks have continued to support their Hungarian subsidiaries, and international reserves have increased.

"To preserve investor confidence, the government needs to strengthen its finances. Fiscal stimulus would do just the opposite."

As a result, the economic outlook is better than it would have been otherwise. With the continued implementation of the program and a turnaround in the global economy, Hungary should see positive growth in 2010.

IMF Survey online: What will success look like for Hungary?

Morsink: Success will be not only stabilizing financial markets but also stabilizing the economy and laying the foundation for strong, durable economic growth. To achieve this, the authorities will need to deliver the fiscal adjustment envisaged by the program and provide the necessary support for the banking system. These policies will help arrest the decline in economic activity and lead to an economic recovery.

IMF Survey online: What will the IMF's role be in bank recapitalization and restructuring?

Morsink: Hungary's banks entered this period of turbulence in strong positions. But they were hit on the liquidity side by the global crisis and, going forward, their capital will be hit by the economic downturn. So, the issue is not to re-capitalize or re-structure the banks. Rather, there may be a need for a precautionary increase in capital. The new bank support law is crucial because it provides for public capital to do this if necessary.

IMF Survey online: Some critics have alleged that there is a secret, unpublished agreement between Hungary and the IMF—and also that the IMF is charging a higher-than-normal interest rate. Is this true?

Morsink: The letter of intent is the whole story—there are no other conditions; there are no secret agreements. As for the interest rate, Hungary is being charged the same rate as any other country that's borrowing from the IMF. The interest rate is based on the rate for the IMF's Special Drawing Rights (SDR), which is an average of interest rates in large, advanced economies. The SDR rate is a floating rate; right now, it is less than 1 percent. In addition, there's a margin of 1 percent. For large loans in relation to the country's quota at the IMF, there are surcharges. Hungary's quota is a little more than SDR 1 billion (€1.2 billion). For amounts between 200 percent and 300 percent of quota, the surcharge is 1 percent; and for amounts above 300 percent of quota, the surcharge is 2 percent. Altogether, the average interest rate on the amount that Hungary has already borrowed from the IMF (SDR 4.2 billion) is currently 2.6 percent.

IMF Survey online: What would have happened to the country if the IMF had not stepped in with financing?

Morsink: Given its very high level of external debt, global investors need reassurance that Hungary will be able to meet its external obligations. Financing from the IMF and the European Union provides that reassurance and helps stabilize financial markets. If there were no credible program or no external help, then financial conditions would have deteriorated more sharply, and this would have created a much deeper economic downturn than the one we're seeing.

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